Monday, June 11, 2012

The Austrian View of the Market’s Tendency to Equilibrium

I will summarise the various Austrian views on the tendency to equilibrium below:

(1) Mises
For Mises, the real world exhibits a tendency to an ideal state of equilibrium, or, as Mises says, the market “at every instant is moving toward a final state of rest”:

“This final state of rest is an imaginary construction, not a description of reality. For the final state of rest will never be attained. New disturbing factors will emerge before it will be realized. What makes it necessary to take recourse to this imaginary construction is the fact that the market at every instant is moving toward a final state of rest. Every later new instant can create new facts altering this final state of rest. But the market is always disquieted by a striving after a definite final state of rest.” (Mises 1998: 246).

(2) Hayek
Hayek’s view on equilibrium evolved over time, and the extent of the changes in his basic ideas has led some scholars to talk about Hayek I and Hayek II as phases in his thought on methodology, and even three phases in his views on equilibrium (Gloria-Palermo 1999: 75). In the first phase down to 1937, Hayek thought that “all legitimate economic explanations should be based upon an analysis of equilibrium” (Gloria-Palermo 1999: 75; McCloughry 1984: viii). The second phase from 1937 to the 1940s involved Hayek’s attempt to redefine equilibrium as plan co-ordination, which occurred in his important paper “Economics and Knowledge” (Hayek 1937; Gloria-Palermo 1999: 75). From the 1940s, there was a third phase where Hayek broke with equilibrium analysis and created a new concept of “spontaneous order” as a method for studying coordination processes in market economies.

Here is Hayek on the concept of general equilibrium from an interview as transcribed in the book Nobel Prize-Winning Economist: Friedrich A. von Hayek (1983, pp. 187–188):

“HIGH: To what extent do you think that general-equilibrium analysis has contributed to the belief that national economic planning is possible?

HAYEK: It certainly has. To what extent is very difficult to say. Of the direct significance of equilibrium analysis to the explanation of the events we observe, I never had any doubt, I thought it was a very useful concept to explain a type of order towards which the process of economics tends without ever reaching it. I’m now trying to formulate some concept of economics as a stream instead of an equilibrating force, as we ought, quite literally, to think in terms of the factors that determine the movement of the flow of water in a very irregular bed.”

From this, is it obvious that Hayek, throughout most of his career, believed in a tendency to equilibrium. Whether, once Hayek replaced general equilibrium with the notion of “spontaneous order,” he still thought that the market has a strong tendency to coordination or “spontaneous order” is unclear.

(3) Rothbard
Rothbard thought that the economy always moves towards an equilibrium state but never reaches it:

“The final equilibrium state is one which the economy is always tending to approach. If our data—values, technology, and resources—remained constant, the economy would move toward the final equilibrium position and remain there. In actual life, however, the data are always changing, and therefore, before arriving at a final equilibrium point, the economy must shift direction, towards some other final equilibrium position. Hence, the final equilibrium position is always changing, and consequently no one such position is ever reached in practice. But even though it is never reached in practice, it has a very real importance. In the first place, it is like the mechanical rabbit being chased by the dog. It is never reached in practice and it is always changing, but it explains the direction in which the dog is moving.” (Rothbard 2009: 320–322).

(4) Gerald P. O’Driscoll and Mario J. Rizzo’s The Economics of Time and Ignorance.
Rizzo and O’Driscoll invoke the concept of pattern co-ordination as an alternative to equilibrium, and see markets as tending to pattern co-ordination (or, that is, some degree of order rather than a strict neoclassical equilibrium state [Prychitko 1993: 374]).

O’Driscoll and Mario J. Rizzo’s The Economics of Time and Ignorance was an attempt to salvage Austrian economics from what they viewed as the nihilism of Lachmann’s radical subjectivist position.

It should be noted how they (O’Driscoll and Rizzo 1996 [1985]: 80-82) see Hayek’s “plan coordination” as just another type of static equilibrium concept.

(5) Ludwig Lachmann and the Radical Subjectivists
Lachmann’s view was that markets do not have an inherent tendency to equilibrium (however defined). It appears that some think that Lachmann’s ultimate views are unclear. Vaughn thinks he regarded markets as subject to both disequilibrating and equilibrating tendencies, but took no position on exactly what tendency dominates the market system (Vaughn 1994: 160; see also Prychitko 1993: 375).

Prychitko holds that there is no a priori basis on which to assert that markets tend to equilibrium states (Prychitko 1993: 375). We have entered a world where expectations may diverge or converge, but even converging expectations are no “guarantee of overall equilibrating tendencies” (Prychitko 1993: 375).

56 comments:

I don't think there is any doubt that Kirzner also supports the idea that the market has a tendency to a state of equilibrium.

For Kirzner, a major equilibrating mechanism is the entrepreneurial discovery process.

See Kirzner's remark:

"The basic methodological foundation for Austrian unhappiness with mainstream neoclassical preoccupation with equilibrium models, has not so much to do with the false and misleading picture of real markets, which standard deployment of these models entails, as with the instrumentalist view of theory which the neoclassical equilibrium-preoccupation came to express. Austrians, in this version of their criticism, need have no quarrel with equilibrium models as such. No doubt significant features of real world market economies can indeed be illuminated by use of such models. But, the Austrian criticism runs, we are surely entitled to demand a theoretical basis for the claim that equilibrating processes systematically mold market variables in a direction consistent with the conditions postulated in the equilibrium models."

Prychitko (1993. “After Davidson, Who needs the Austrians: Reply to Davidson,” Critical Review 7.2–3: p. 375) characterizes the "middle ground" Austrian position as the view that the market process is a "fundamentally equilibrating process", and describes this "the Mises-Hayek-Kirzner story".

The seems to be the moderate subjectivist Austrian position, though O’Driscoll and Mario J. Rizzo in The Economics of Time and Ignorance have departed from it (or so it would appear to me) by seeing "pattern co-ordination" as an alternative to equilibrium, and merely as some degree of order, not an equilibrium state per se (see Prychitko 1993: 374 on this, an enlightening discussion).

I think all of the Austrian you have cited would agree that there exists in a free-market both tendencies towards equilibrium (uniformity of profit etc) and tendencies away from equilibrium (change in consumer preference and supply-side innovation etc). Most Austrian would however believe that the biggest dis-equilibrating force by far is intervention in the market (subsidies, minimum prices, UI, etc)..Apart perhaps from Lachman it is pretty clear that the big-name Austrians all believe that if one removed interventions from the market then the economy would move closer to equilibrium than what we see in the "mixed economy" models and while changing economic data would stop this equilibrium actually being reached the clear vision is of an economy staying close to equilibrium with the dis-equilibrating tendencies causing small ripples within a mainly equilibrium framework.

"(1) equilibrium rate of interest clearing the loanable funds market"The CB sets the interest rate and controls the money supply so when the market fails to clear at the zero-bound its hardly a free test of free-market processed

"(3) Say’s law"If understood to mean that there is never any reason why a market can not clear (if relative prices are set correctly) then it exists.

"(7) significant and quickly flexible wages and prices"Many examples of inflexible prices are in reality examples of price controls and/or subsidy (for example wages are influenced by the existence of UI and minimum wages).

"(2) tendency to equilibrium prices"Give me one example of a price that is set by the market (with no intervention) where there is no tendency to equilibrium.

(1) the unique Wicksellian natural rate of interest used by Hayek in Prices and Production and still used by R. garrison is a myth.

(3) Say's law is nothing but a fantasy.http://socialdemocracy21stcentury.blogspot.com/2010/10/myth-of-says-law.html

(7) Many businesses and corporations set prices, and do not adjust them over significant periods of time: this has nothing to do with government, it is a market phenomenon.

The problem of wage stickiness is a well known one in modern economics. People in general object to having their nominal wages cut. Even managers often dislike across-the-board pay cuts. Recent studies suggest that employers avoid pay cuts because they diminish workers’ morale, and then falling morale reduces productivity (Bewley, T. F. 1999. Why Wages Don’t Fall During a Recession, Harvard University Press, Cambridge, MA).

I think Post-Keynesian generally are confused by the issues of price stickiness and monetary disequilibrium.

To a post-Keynesian the fact that (other things being equal) the volume of sales will go down if the demand for money rises is used as some kind of proof that Say's law doesn't hold. They appear to miss the fact that a combination of the money-supply increasing in response to the increased demand for money and the prices of other goods falling in response to the decreased demand for goods would quickly bring the market back to equilibrium. Both these things are hampered in a "mixed economy". The CB control the money supply for political ends and the govt widely intervenes in the labor-market with the effect that the supply curve is flattened and prices become inflexible.

The fact that business set prices in the way you describe and that workers object to wage cuts is somewhat irrelevant. In an unhampered market where the economy stays close to equilibrium the demand for money and the demand for labor will be reasonably constant with minor variations taken care of by adjusting the supply of money.

If some unforeseen circumstance throws the economy into a extreme disequilibrium then the only way to fix things is to allow prices to find their new relative levels as quickly as possible - including the new price for money. Any attempt to find a quick-fix (by adopting the policies recommended on this blog for example) will have further dis-equilibrating effects and prolong the recession.

Besides, your notion that the US government intervenes widely into labor markets is bizarre. Prove it.

Moreover, in the Great Depression, there was no unemployment insurance, or minimum wage. The fact of the matter was that firms had no market for their goods, so they cut labor and stopped producing. Plus, there was a large private debt overhang, causing people to pay down their debt instead of spending on investment or consumption goods. And as we should agree, investment and capital accumulation drive economic growth.

In depressions or recessions, investment falls, causing Income to fall-this is obvious. But really, when does the fall in production stop? There is no evidence for marginal substitution of labor for capital in recessions, so a recession could end quickly or drag on forever. The point is WHY? There is no economic reason to endure unemployment. Instead, the reason is political and philosophical.

I'd rather you would argue along those lines than along economic ones. Increased state control of enterprises is something we should be very cautious of. However, building roads, or updating the power grid are not.

The problem, is that equilibrium is a fictitious construct. Keynes didn't buy it, nor do any other Post Keynesian's. And, even if there was, we would never know it, so it is pointless to hope and pray for full employment that may never happen-especially when we can create full employment ourselves.

Essentially, the Austrian viewpoint is a world without fixed contracts. The only problem is, that fixed contracts are actually very practical and reduce transaction costs substantially. Imagine trying to find a new mortgage every year in a world of uncertainty, or renegotiating your contract for wages every month or couple of months. You couldn't undertake plans.

You should read Selgin's "theory of free banking" or Hayek's "denationization of money" for an understanding behind the view that free markets may throw up institutions that would stabilize the "price of money" and reduce the risks of both artificial debt-driven booms and deficit-demand-driven recessions.

I think binding fixed-price contracts fit in quite well with (non-Rothbardian) Austrian models. I thought it was the Post-Keynsians who always wanted debts to be written off to get us out of recession ?

I disagree with your point about equilibrium - it seems quite easy to define it and to identify an economic system that will bring us close to it. I certainly prefer it your model where "full-employment" is the paradigm - didn't the eastern block always used to boast of their 100% employment rates ?

I think both the great recession and the great depression are primarily caused by bad central bank monetary policy - inflexible labor markets are a bigger factor now than in 1930's but that is not key to my argument.

"I think both the great recession and the great depression are primarily caused by bad central bank monetary policy"

There was loose monetary policy after WWII in many nations, yet the West wasn't hit by huge asset bubbles and private debt crises. Even when a wall of petrodollar money hit the West in the 1970s-early 1980s the Western nations was still not hit by the type of highly speculative lending and asset bubbles we saw 1990s-2000s.

The reason was the existence of reasonably effective financial regulation back then.

Blaming the central bank is merely short-sighted: the real issue is poorly and badly regulated banks and financial systems. When the private sector banks/financial institutions can pump out the liar's loans and NINJA loans without regulatory penalty, the system is seriously flawed.

Well, again Rob, your argument is a political one, not an economic one. And I more or less agree with the idea of a decentralized state with low taxes and a full grasp of modern money.

Besides, we fundamentally disagree about how prices are formed-or better said administered. Post Keynesians reject marginal pricing. There is, for example, no evidence of switching between labor and capital anywhere. Sraffa and Robinson demolished Samuelson and Solon in the Cambridge Capital Controversy.

Plus, the Eastern block has nothing to do with Keynes or Post Keynesians. Keynes was certainly pro capitalist and anti socialist.

Are not bad CB policy, bad govt regulatory policy and a cartelized banking-system that benefits from these things all part of the same system ?

I argue that without a CB that controls the money supply serious failures (when the economy veers away from equilibrium and doesn't return quickly) like the Great Depression or the Great Depression would be very unlikely to occur.

I simply don't understand the theory behind post-Keynesian assertions that the banking system independent of the CB can drive large increases in the money supply.

CMD: I think if you study Bohm-Bawerk you will see that Austrian's have a perfectly good explanation for mark-up prices. I don't really see how this is relevant to the discussion.

I get that Post-Keynsians believe they are saving capitalism from itself - I was just pointing out once you set goals like "full emplyment" you are likely to undermine the free market no matter what your intention may be.

I am not sure if Garrison falls into the moderate subjectivist Austrian position, to tell the truth. Probably he does.

I'll just note as an addendum that on p. 100 of The Economics of Time and Ignorance, Rizzo and O’Driscoll seem to regard Kirzner as using Hayek's "plan coordination" concept as his version of equilibrium.

Yet another point is that O’Driscoll and Mario J. Rizzo's The Economics of Time and Ignorance is an attempt to salvage Austrian economics from what they view as the nihilism of Lachmann's radical subjectivist position.

It should be noted how they (pp. 80-82) see Hayek's "plan coordination" as just another type of static equilibrium concept.

1)The natural rate of interest is conducted with money. There are not multiple natural rates of interest. I've cited Mises on this and repeated this point, literally ad nauseum on your blog.

2)In the modern world, 7 is due to government promoted rigidity and creating a general environment where prices creep upwards. Not to mention that the idea of "significantly and quickly flexible" is a complete arbitrary and subjective judgement. The flexibility on the free market is the proper "flexibility".

Entrepreneurs are always in the process of trying to sell a produced stock of goods at their highest price (the equilibrium price) that maximizes total revenue, and produce a future stock of goods at their highest price (equilibrium price) that maximizes net revenue. Buyers, on the other hand, in both the role of consumer and producer always try to buy the most profitable stock of goods (the cheapest price). These, along with the laws of demand and supply, are the general laws of price theory. Whether or not markets actually tend to equilibrium, because of "poor market entrepreneurship" or constantly changing data is actually immaterial to the success of the free market. The first is actually a technological "skill" of the marketplace, while the second should be seen as a positive and beneficial thing, to have consumer preferences and technologies constantly change instead of settling into a banal groundhog day routine. With any skill of entrepreneurship, the important thing is that market participants are always in the position to use economic calculation and profit and loss to allocate scarce goods in an economy. The continuing "plain states of rest" that occur with each and every exchange are proof that wants are being satisfied and the market efficiently utilizes resources. Only with a improper Neoclassical idea of welfare do you get the requirement that markets need to always be at equilibrium for them to work properly

"The natural rate of interest is conducted with money. There are not multiple natural rates of interest. I've cited Mises on this and repeated this point, literally ad nauseum on your blog."

What? You're saying their is a unique Wickellian natural rate?

"Whether or not markets actually tend to equilibrium, because of "poor market entrepreneurship" or constantly changing data is actually immaterial to the success of the free market."

No, it isn't.Let me get this straight: if a free market results in significant unemployment, this is "actually immaterial to the success of the free market"?. lol.

"In the modern world, 7 is due to government promoted rigidity and creating a general environment where prices creep upwards."

Again, no.

The problem of wage stickiness is a well known one in modern economics. People in general object to having their nominal wages cut. Even managers often dislike across-the-board pay cuts. Recent studies suggest that employers avoid pay cuts because they diminish workers’ morale, and then falling morale reduces productivity (Bewley, T. F. 1999. Why Wages Don’t Fall During a Recession, Harvard University Press, Cambridge, MA).

I'm saying that there are not multiple natural rates of interest in a barter economy. Arbitrage works towards the multiple monetary rates of return in an economy to equilibrate. You keep repeating ad nauseum the erroneous view of final equilibrium barter. In catallactics, time preferences work through money. Mises did not hold the barter view later in his life, nor did Rothbard (ever).

"No, it isn't.Let me get this straight: if a free market results in significant unemployment, this is "actually immaterial to the success of the free market"?. lol."

Your actually missing the point. Each laborer tries to sell his good (labor) at the most remunerative price while the buyer (the entrepreneur) tries to buy the most lucrative quantity of labor at the most profitable price (cheapest). Combined with the general non specificity of labor, these two forces work towards laborers all getting employed at some price in each respective market. Whether or not they actually reach a period of full employment where every worker is paid his DMVP and in his most capable position is irrelevant. But on the market, the workers who want to get employed get employed. This is different than a producer selling a stock of goods that consumers may or may not want to buy. If the entrepreneur incorrectly estimates wants and produces bad goods, then he has to slash prices and may or may not sell his entire stock. Laborer is a commodity that every consumer needs in the creation of their goods and every firm wants. Laborers that produce ineffecient "goods" (e.g., services the economy doesn't need) always have the option of going into another line of work. Significant labor idlenss only occurs to the extent that workers choose voluntary unemployment (above market wage rates). "

People dislike having their wages cut? I never knew. Employers don't have to engage in considerable wage cuts in the modern world because society has adjusted to a slow upward increase in the price level. During recessions prices only rise slower, the price index rarely falls now. Not to mention that if firms significantly reduced wages, workers have the option of refusing and instead going on unemployment benefits. What firms say in surveys (especially endorsing a fallacious view that morale heavily influences productivity, when in reality it is saving and the capital tools they work with) is irrelevant. Especially since this view clearly did not hold in the 1800s, when you had a more flexible labor market. There is a clear reason why labor unemployment is secularly higher in Europe than in America: government induced rigidity.

Except, he doesn't. All he does is show that a natural rate of interest can't exist in a barter economy. But who ever said the ERE was? Mises was very clear that interest was a monetary phenomenon later in his life. You only agree with Murphy because his conclusions agree with your belief.

Murphy: "As such, there is still no way to examine a barter economy, even one in intertemporal equilibrium, and point to “the” real rate of interest.”

Mises: "Only within a money economy can this value difference be comprehended in the abstract and separated from changes in the valuation of individual concrete economic goods. In a barter economy, the phenomenon of interest could never be isolated from the evaluation of future price movements of individual goods.” P.83. Ludwig von Mises, “The Position of Money among Economic Goods”, taken from Salerno, Money: Sound and Unsound.

"This very idea is dependent on the assumption of a market convergence to full employment equilibrium - which does not exist."

Except that it doesn't, at least in the same sense as all other markets. Labor is the unique commodity that is required in all production processes and can is relatively nonspecific. If a worker is unemployed, he knows he can lower his asking price and look for jobs that offer lower wages. Unlike a producer that sells a good that no one wants, the laborer sells a commodity that is demanded everywhere (and unlike produced specific capital/consumer goods, is nonspecific and downward mobility). The speculative labor unemployment from moving between lower and higher labor markets and changing underlying fundamentals from changes in the data are what prevent the labor market from converging to a equilibrium where everyone is employed at the position of their highest DMVP.

"But this is really just another real theory of the interest rate where loans are imagined as occurring in natura, or in real commodities in an economy at full employment. Mises is still subject to Sraffa’s critique of Hayek."

But Mises (from what I posted) says otherwise. You just want to read Mises in the way that best fits your views, when your reading is not what Mises meant.

"Workers cannot just lower their wage rates when they have high levels of debt and require a minimum level of wage to not starve or be homeless."

Now you are just throwing out the populist appeals. With large amounts of consumer debt (provoked by the inflation), consumers will go bankrupt (and face the penalty) and/or readjust with loaners (and in the long term/secular deflation, rent more than borrow). The crushing burden of consumer debt happens right now because the economy isn't allowed to adjust (housing market propped up, car markets bailed out, student loans continue to be heavily subsidized by government) and everyone thinks inflation is on the horizon.

Now, the minimum level of "starvation" is another populist appeal. However, especially in our advanced industrial society where labor is nonspecific, this is unlikely to hold. It is only true in a society where land is scarcer than labor (e.g. medieval era) where many market clearing wages would be below subsistence. But the only way to improve such a horrible condition is to increase the capital stock, and that can come only through saving.

"Furthermore, general lowering of wages will just cause debt deflation in environments of high private debt."

For business debt (consumer debt dealt with above), creditors are to the extent they own the property entrepreneurs and can adjust accordingly. They can adjust the loan rate, hire a new manager (give out a loan to a different person), or run the business themselves. When they decide to close down the business it means the resources could be better used elsewhere.

"Also, wage cuts will just depress AD if prices are not adjusted uniformly - and price flexibility is just another neoclassical and Austrian myth."

The keynesian fallacy that cuts to wages decrease consumption spending and provoke further declines in aggregate demand are only true to the extent than the demand for labor is inelastic below the wage rate. This argument commits the fallacy of confusing wage rates with wage income. And, building off what I said above, prices are as flexible as people want them to be. Perfect and instantaneous flexibility is not only impossible, but not needed in a market economy.

(1) Does Mises or does he not subscribe to an originary interest rate?

(2) "with large amounts of consumer debt (provoked by the inflation), consumers will go bankrupt (and face the penalty) "

lol ... so you're just admitting it would cause debt deflation collapse, which makes an utter nonsense of your belief that such wage cuts would allow some smooth tendency to a new full employment equilibrium.

Once subjective expectations of business are thrown in, you will possibly have depression for years on end, and once recovery comes high unemployment for years too, just as in 1870s and 1890s America, when there was some degree of wage and price flexibility:

And on prices, I'll just note how even Lachmann appears to have endorsed the Post Keynesian theory of price setting (that is, the manner in which certain businesses determine prices by a profit markup over cost of production, and often leave the prices of their commodities unchanged for significant periods of time).

"(1) Does Mises or does he not subscribe to an originary interest rate?"

Yes, and originary interest is conducted in terms of money. Mises thought otherwise earlier in his life, but clearly changed his views.

"lol ... so you're just admitting it would cause debt deflation collapse, which makes an utter nonsense of your belief that such wage cuts would allow some smooth tendency to a new full employment equilibrium."

No, I'm not. How am I admitting a debt deflationary collapse? I've given a pretty good brief explanation of how an economy can adjust.

"More likely it will mean huge idle resources and unemployment."

The resources are idle only to the extent that entrepreneurs withhold them in the present for a higher prospective use in the future.

And again, with the Vernon unemployment rates? Everywhere I go I always see you using and reposting them. I’ve given my criticisms of the paper, e.g. how they simply use a Okun Law style regression (using a regression deviation of unemployment and output from 1900-1940, when there was a much higher percentage of wage rigidity!)), Balke-Gordon etc, and they make 1873 full employment when it should be overemployment due to the boom.

Yes, if consumers can't pay they default. The creditors can sell continue to loan, rent, or sell their property (with obvious price adjustments). Just like when businesses fail, their factors of production don't just blow up. More capable entrepreneurs can buy them and utilize them more efficiently.

"That words and sense of "only to the extent that ..." are just utter garbage: they don't use them because there is insufficient demand for their products and their expectations have collapsed."

Yes, because the price that they could fetch on the market right now is insufficient to them, and they think that they can earn a higher price in the future. However, if they cannot earn a higher price in the future, they will sell it at the given price, and with costs adjusting. Insufficient demand doesn't matter, what matters is cost revenue spread.

(1) Mass bankruptcy of debtors will also cause mass bankruptcy of creditors, especially when the underlying asset (say, an originally overvalued house) has collapsed in value. If the financial sector is allowed to collapse (as in America 19301-1933) millions will lose their savings they hold in the form of FR demand deposits. Depression will result, despite your fantastic ramblings. Did America adjust rapidly to a full employment equilibrium in 1932-1933, when mass bankruptcies occurred?

Other debtors (from liar's loans, NINJA loans) will have virtually no assets at all.

(2) "Yes, because the price that they could fetch on the market right now is insufficient to them, and they think that they can earn a higher price in the future."

Wrong: they are not investing because they see now (and expect in the future) insufficient demand for the products.

May I ask you your work experience and what part of the country you live in? In the Philadelphia area I have been a controller for three manufacturing companies and work as a financial analyst for two financial institutions. Your post Keynesians insights in price and wages inflexibility does not line up with my experience. Consider the following:

1) In terms of wages employees are not only paid wages but also bonus and overtime. This part of employee’s wages is very flexible given increases/decreases in sales and in turn production.2) Industries in decline such as the commercial printing industry have had on going wage cuts for several years due to reduce sales and profit.3) Sales and marketing departments adjust price based on customer demand and competitors ability to met customer demand. If a product or customer is losing money or is not generating an acceptable return in investment the price is increase or the customer is drop if the price increase was not successful. A company could also find way to reduce labor or material waste as well to increase profit.

Again can you give me specific examples in your experience of wage and price inflexibility?

(1) the fact that wages are not flexible in the way imagined by neoclassical or Austrian economies is an empirical matter supported by so much evidence there is no doubt about it;

(2) I fear you have taken the description above too literally: nobody denies that one can point to price cuts and wage cuts in the real world.

Even price setters cut prices sometimes.

But the point is that prices and wages in general do not adjust in the manner imagined in the neoclassical theories: smooth, rapid and significant adjustments that supposedly clear markets as their tend to the fantasy general equilibrium state.

Hoodnick, adaptability to changes in demand are due to technological progress not marginal wage and price switching.

You know, as a financial controller, that you forecast average total costs and profits and set prices accordingly.

Marginal pricing implies that every price is different because the balance between supply and demand changes. This is obviously not true.

Think about toasters. If you produce 10 toasters at 10$ each, you would need to set the price per toaster at 1$ to break even. Then, given your companies mark up or target rate of return you add the mark up to the average cost (1$). If your mark-up is 50%, you set the price at 15$ per toaster.

Post Keynesian price theory is more intuitive and my future professor Fred Lee is an expert on the subject, so I would encourage you to read his emipirical work.

The cost+markup=price theory doesn't take into the account of entrepreneurship and changes in price, and makes the fallacy that cost determines price, when in reality it is the other way around. An entrepreneur may certainly wish to get a certain markup on his product when producing a good, but after a good has been sold, if no one buys it or alot of people buy it he will change his price. We see this all of the time at retail stores.

Clearly they won't, unless they are selling some products below cost in some areas while selling them above cost in other areas (on the whole, it is more profitable to produce the greater stock then not). Certainly all businesses strive to sell above cost, hell, thats the only way they can earn interest and profit. But cost does not determine price, and entrepreneurial pricing appraisements are not just simply cost+ markup=price. The price an entrepreneur believes he could fetch on a market is what limits what he will pay for his factors.

"The price an entrepreneur believes he could fetch on a market is what limits what he will pay for his factors."

This statement is similar to the question of what came first, the egg or the chicken.

If the entrepreneur is a price-taker, factor prices are a given of the market (i.e. the entrepreneur cannot change them: they are a constant, a parameter). Those factor prices translate into the entrepreneur’s costs of production.

If at that unit-cost of production the unit-price the entrepreneur can fetch for his/her product is not enough for him/her (taking into account profits) there is no production.

The price taker idea is an erroneous fallacy that does not take into consideration the fact that every entrepreneur has some influence on the price. An entrepreneur unable to lower his costs is not due to the fact that he has no influence at all, but rather that the factors do not have to accept lower prices because they could earn a higher price elsewhere on the market. The entrepreneur's decline in demand for a factor is offset by another firm increasing its demand, or a firm's increase in demand is offset by an increase in the supply of a factor. Ceteris paribus, even the slightest change in the underlying fundamentals provokes a change in price.

I apologize for this remark, but I think we need to be precise with our language.

To say "producers are price-takers" is an assumption. Not a fallacy (a fallacy is a "wrong" argument), let alone an "erroneous fallacy" (because there cannot possibly be "correct fallacies").

Now, you can certainly say "every entrepreneur has some influence on the price" (quoted verbatim from your previous comment) and that is quite probably true. By saying that you are saying: "I reject that assumption".

However, to simply reject the assumption is not enough to make your point. Think of it this way: it's your word against mine. At best, by doing so you can hope to reach a stalemate (if I couldn't prove my point).

To prove your point that product unit prices determine (note the word: "determine" as in your quote in my first comment) factor costs, you need to prove that every entrepreneur is capable of determining (not simply "influencing") factor prices.

Or, at the very least, that in general a majority of entrepreneurs can determine their factor prices.

Now, that is a challenge, simply because not all entrepreneurs can do that: think for instance of Texas and Northern Sea oil producers. Oil prices go up, they extract oil; oil prices go down, they stop extracting oil. Similar happens with Alaskan oil: now that commodity prices are falling, we don't hear that much talk about Alaskan oil, do we?

Oil producers behave this way, because regardless of oil price, their production costs remain the same and with low Brent or West Texas Intermediate prices, their revenues are not enough to cover their costs and bring them the return they demand.

So, how are you going to prove your point?

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Second, aren't we being a bit tricky here?

"An entrepreneur unable to lower his costs is not due to the fact that he has no influence at all, but rather that the factors do not have to accept lower prices because they could earn a higher price elsewhere on the market."

To say that "factors do not have to accept lower prices because they could earn a higher price elsewhere in the market" is a longer but logically equivalent way of saying that the entrepreneur is a price-taker in the factors market.

I may be mistaken, but what you seem to imply in the quote above is that the entrepreneur is operating away from its optimum: he/she can always reduce costs by cutting extra "fat" (i.e. non required expenses). But this means that the entrepreneur is inefficient.

To make the above clearer: if an entrepreneur is operating at his/her optimum, every little change leads to a sub-optimum. But optimality in resources allocation is synonymous with efficiency.

Now, it may well be true in real life that entrepreneurs are inefficient. But what is it that each and every free-market economist, Austrian and neoclassical alike, says about markets and efficiency? That markets are efficient!

“To say "producers are price-takers" is an assumption. Not a fallacy (a fallacy is a "wrong" argument), let alone an "erroneous fallacy" (because there cannot possibly be "correct fallacies").”

Unless I meant that your argument was double wrong, and then it was correct :P

“To prove your point that product unit prices determine (note the word: "determine" as in your quote in my first comment) factor costs, you need to prove that every entrepreneur is capable of determining (not simply "influencing") factor prices. Or, at the very least, that in general a majority of entrepreneurs can determine their factor prices.”Saying entrepreneurs “determine” factor prices is misleading, pricing is a mutual bargaining process on both parties. “Posting” prices is not the same as determining. Each side (demand and supply) can only influence prices, they can’t determine them without the other side. Its not an added assumption, its how the pricing process works in every industry.

“Now, that is a challenge, simply because not all entrepreneurs can do that: think for instance of Texas and Northern Sea oil producers. Oil prices go up, they extract oil; oil prices go down, they stop extracting oil. Similar happens with Alaskan oil: now that commodity prices are falling, we don't hear that much talk about Alaskan oil, do we?

Oil producers behave this way, because regardless of oil price, their production costs remain the same and with low Brent or West Texas Intermediate prices, their revenues are not enough to cover their costs and bring them the return they demand.”

If the price of oil falls (from the demand side, not the supply side), they stop extracting oil instead of lowering their costs because they believe that the price will go back up in the near future and it is more profitable to wait. And vice versa. If oil prices stay low, then they will lower their demand bids for factors. Now, if the companies’ demand curve shifts to the left, the supply curve (say for intermediate products or labor) may shift to the left because the owners of those resources feel that they can fetch a higher price in a different occupation and the price will remain the same (for example, from competing oil industries, who may correctly estimate that the price will soon rise). If they don’t, then they will accept the lower price. Now the supply curve of labor may be upward sloping, so less workers will engage in the extraction process, but the price will drop. For a given stock of produced goods (vertical supply curve) the lower price fetches the previous quantity supplied. Oil prices are extremely volatile and go up and down, and entrepreneurs must use their judgment to appraise the situation and determine what the next most profitable action is. Oil producers still have influence over their prices, just like the suppliers of their inputs (intermediate products, labor, machines, etc) they are not exogenously determined by the market. For then who determines prices?

To say that "factors do not have to accept lower prices because they could earn a higher price elsewhere in the market" is a longer but logically equivalent way of saying that the entrepreneur is a price-taker in the factors market.”

No, because ceteris paribus, the entrepreneur has an influence on the market. In the above example (which is what I was talking about), the entrepreneur lowered his demand for factors, but the supply curve changed (violating ceteris paribus). If the supply curve did not change, then the price would be lowered.

“I may be mistaken.... That markets are efficient!”

No, I am not talking about reducing “extraneous costs”, I am talking about lowering the prices of inputs so the entrepreneur produces the same stock of goods to earn a similar return to what he had before. It relates to the profit and loss system, if entrepreneurs earn profits in a particular industry, other competitors will flock to that industry, bidding up the prices up inputs while the increased supply of the product lowers individual firm revenues until a “normal rate” is earned again. And vice versa for losses. This process is obviously not instantaneous, nor does this process ever come to fruition in all industries because the underlying data is always changing.

I'm confused at why you repeat that neoclassicals embrace flexible prices. Take any look at a modern macroeconomics book (e.g. Mankiw), and you'll see that price stickiness plays a fundamental role in how they view business cycles. New Keynesians and Monetarists need the assumption of sticky prices for AD-AS/IS-LM to work.

You have missed the point here. Post Keynesians specifically deny that price and wage flexibility leads to full employment equilibrium.

Both monetarists and New Keyensians (NKs) think the economy would adjust to full employment equilibrium if only for wage and price rigidity.

The NKs do in fact acknowledge price and wage rigidities in the real world as an impediment to full employment.

I am not sure about monetarists. I suspect that they recognise real world, short term price and wage rigidities, but think in the long run things are flexible.

By the time you get to the Chicago-school New Classicals, you are in a la-la land of absolute neoclassical fantasy about what happens in the real world.

E.g.:

"While Keynesian macroeconomics rests on the assumption of price rigidity, new classical analysis states that a shift in demand is always matched by a change in prices allowing for the clearing of markets."

"At least in the modern world, internal prices are highly inflexible. They are more flexible upward than downward, but even on the upswing are not equally flexible. The inflexibility of prices, or different degrees of flexibility, means a distortion of adjustments in response to changes in external conditions. ... Wage rates tend to be among the less flexible prices."

Yes, clearly Friedman thought prices were sticky in the short run. Which is why he advocated monetary policy (in a similar vein, Selgin and White advocate NGDP targeting or a free banking system that would offset declines in nominal spending for the reason that prices are sticky, especially downward, with respect to changing demand.)

My point was that you have generally said "Neoclassicals", as if all of them assume perfectly flexible prices, when in reality they do not.

"Wrong: they are not investing because they see now (and expect in the future) insufficient demand for the products."

Please take an introductory finance class. You obviously are not familiar with net present value or any other basic financial concept. Decisions to invest depend on a wide range of factors, of which guesses as to whether or not the government will act to increase AD next year is a minor part.

We can't simply assume that all businesses will increase investment due to a govt-led increase in AD, nor can we assume that investment won't increase in certain industries without such an increase. Google will invest resources in pushing a Google-branded tablet this summer, while Blackberry will probably have to reduce investment in future products due to its rapidly diminishing market share. These outcomes are due to market and technology changes. The correlation btw these decisions and govt policy is almost nil.

Do sales in every industry positively correlate with increased govt spending?

Example: Best Buy will almost certainly reduce investment in the coming years. Why? Because the big box retail model is being destroyed by online retailers. This is due to changes in technology. All the govt spending in the world wouldn't induce Best Buy to increase investment. At same time, a company like Netflix will almost certainly increase its investment, due to the success of its business model and growing revenue. This would probably occur even if the overall economy experienced little or no growth (and certainly is independent of increased govt spending).

Changes in technology are what drive changes in the economy (and increase the nation's productive capacity and technology). Temporary AD-pump priming will do nothing to change this, except add to our debt.

"Nobody at the sharp end in a real modern business spends any time worrying about interest rates, and surprisingly little time worrying about costs."

This is wrong on so many levels. To state the most obvious examples: You really don't think Wal-Mart worries about costs? Or that when firms finance projects with corporate bonds they don't care about interest rates? Give me one example of a large firm that doesn't pay attention to interest rates and costs.

Obv sales projections are vital, but as I said, sales in each particular industry vary with technology/market trends. Short-term govt stimulus MAY increase sales in SOME industries, but the effect will of course be temporary and will not change the long-run destiny of the economy.

"Anybody suggesting that investment comes before consideration of the sales environment frankly needs to get out of their ivory tower."

I never said this. I said, "Decisions to invest depend on a WIDE RANGE of factors." Sales projections are obv an important part of investment decisions.

Ecosystems reach equilibrium through elimination of subjects and species.

Even if this mystical equilibrium was true (although always momentary, so it ain't a real equilibrium but a flow of the system status, there is no equilibrium when the equilibrium is lost, the nature of the system is chaotic and changing), what does it mean?

Equilibrium is not the problem, resilience is the problem. What does it mean to be in equilibrium when 1% of the population hoards most wealth and secures rent channels at stops social mobility or people is pushed into poverty? This 'equilibrium' is self-defeating and gives place to regime changes, collapses of the social fabric and revolutions.

It looks like Austrians don't know nothing about history and the human action they talk about so much. An please don't tell me that 'if governments stop manipulating it all will change' there is no empirical evidence of that, exactly the contrary.